The 10 most profitable dividend paying shares

Profitability measures such as return on capital employed (ROCE) are a useful way to gauge the “quality” of company. If a company can generate consistent returns on capital far above the cost of capital, that alone suggests some kind of durable competitive advantage or economic moat.

If the company didn’t have a competitive advantage then other companies would copy what it was doing in order to earn those same high rates of return. That in turn would increase competition and decrease profit margins and profitability.

As a defensive value investor I’m interested in combining the defensive investor’s love of relatively defensive, high quality companies, with the value investors preference for low prices.

One way to find such companies is to look at very high quality companies, using measures such as profitability or return on capital employed, and then weed out the ones that appear to be too expensive.

In an effort to do that, here are the current top 10 companies from my stock screen as measured by ROCE:

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ROCE in this context is in fact the 10-year median net ROCE, where net ROCE is ROCE calculated using post-tax profits rather than operating profits. Doing it that way means that interest payments are factored into the result, so companies with large debt and interest obligations typically have lower net ROCE scores.

Selection criteria

Every one of those 10 companies has a 10-year unbroken record of dividend payments and has produced a 10-year net profit as well (i.e. total profits were more than total losses). But it is possible to be far more selective.

Excluding expensive shares

Generally I don’t like to invest in anything where PE10 (share price to 10-year average earnings ratio) is greater than 30. In the table you can see the stocks that fall above that level as their PE10 value is highlighted in bright red.

Where PE10 is coloured light red (or pink) its value is less than 30 but higher than the market average, i.e. the FTSE 100, which currently has a PE10 ratio of 15.

So most of these stocks are more “expensive” than the market, but that’s reasonable and to be expected because, quantitatively at least, they are all “better” than average companies. In other words they have all grown faster and more consistently than the market as a whole (any value in the stock screen table which is better than the FTSE 100 equivalent is coloured green).

Focusing on the cheapest, most profitable dividend paying shares

From this group of highly profitable dividend paying shares, Admiral stands out.

It has a dividend yield of 6.5%, including the “special” dividend which the company has paid out every year since it listed on the stock exchange. It has grown at almost 13% a year, with 87.5% consistency and has no borrowings.

It also has a ROCE figure of 53.73% in the table, although as it’s an insurance company that figure is actually for return on equity (ROE), because ROE makes more sense than ROCE due to the structure of insurance company balance sheets.

Admiral does “cheat” slightly in that its amazing profitability is driven to a large extent by a heavy reliance on reinsurance (taking out insurance on a proportion of the risks the company has insured) and coinsurance (sharing risks with other insurers). However, as far as I can see it still appears to be a well run business.

The other relatively “cheap” companies are De La Rue and PayPoint, although as ever with “cheap” companies, there are always problems to consider.

In De La Rue’s case, the dividend has recently been almost halved, while PayPoint may have to pay an additional £1m to £2m in VAT, which will negatively impact its current adjusted post-tax profits, which are about £35 million.

While I cannot say which of these stocks will do well in the future, I can say that each of these businesses has produced exceptionally high returns on the capital employed within their businesses.

In many cases it’s likely that those outstanding results were driven by some sort of sustainable competitive advantage, which is exactly the sort of thing sensible investors should look for.

Reader Interactions

Comments

Great article John. I love how you use these 10 year averaged versions of the usual metrics most value and DGI people use.

Paypoint is an interesting one – do you think we should really worry about the tax issue? If it’s still a good company, then it might still be worth looking into further for a potential investment.

WHSmiths, Domino’s, and Micro Focus have all been constituents of my monthly watchlists at some point over the last several months, so they have been on my radar for some time. Of these, I like WHSmiths the most – a strong brand name and their travel division is pretty ubiquitous and almost a daily part of life.

Hi M, I haven’t really looked at PayPoint in any great detail. My point about the tax issue was just that there are usually issues somewhere or other in any apparently “cheap” stock. So if the tax issue is a non-issue (it’s less than 10% of current profits, so might not mean a dividend cut and essentially just sets the company back a couple of years in terms of profit) then PayPoint may be quite attractively priced.

Which basically says it was a bit expensive for me at 1,100p. It has gone up since then so it’s still a bit too pricey for me and the 2.7% yield is a bit stingy (although I accept that it may grow faster than the market average).

Nice article as usual! I am finding it interesting to start seeing the investors difficulty in determining how to choose a stock that is a good investment over the long term. I personally do a lot of work in the area of intangibles and the growing gap between book values and “market values.” The true value of an organization cam no longer be determined from accounting information so we have to rely on what the market thinks. Yet a large proportion of market is driven he the herding instinct rather than really understanding underlying value. Your long term view of consistent results combined with growth starts to sort out the noise. Many organisations have a large proportion of intangible value (i.e. excess of market over book) but how do we know how well management is nurturing these intangibles and creating an effective competitive advantage from them. Again your approach in “track record” start to help “sniff out” the better performers. An important issue here is to be able to create sustainable profits that are “optimized” rather than “maximized.” Thanks again.

Good to hear from you again. Your point on intangibles is definitely relevant here because highly profitable businesses, especially those that have been highly profitable for a long time, do very often rely on intangible assets.

In this case by “intangibles” I don’t mean (and I think you don’t mean) the intangibles that are on the balance sheet, but intangibles that are “off balance sheet” and almost impossible to measure.

So a company might produce high returns on capital employed, but that’s because we’re looking at “capital employed” in terms of what’s on the balance sheet. If the company is able to employ “off balance sheet” intangibles, typically a unique asset of some sort such as a brand (Coke) or marketplace (eBay), then the capital employed is actually more than it appears to be; it’s just that a large part of that “capital” isn’t on the balance sheet.

And given that we’re after durable advantages it makes total sense to me to look at a company’s results over a long period of time, because if the results weren’t durable in the past there’s no reason to expect them to be in future. Although of course no company’s future results are guaranteed.

Not sure how we can differentiate between “optimised” profits and “maximised” though. I guess you mean the difference between maximisation of long-term value (i.e. discounted value of future dividends, or similar) as opposed to just maximising near-term profits (typically to maximise executive bonuses). That’s one of the reasons I don’t obsess (yet) about free cash flow, because I’m quite happy to see a company invest heavily in the future, and therefore have little – if any – free cash. I’m sure there’s a metric in there somewhere that could sort one from the other, but I don’t know what it is yet!

Hi Richard, I collect data from a variety of sources, mostly online and mostly free. It all goes into a (big) spreadsheet which I update each weekend. I have been meaning to move to “proper” database software but have yet to get around to it, although I do find spreadsheets very easy to use. At some point I would like to buy a “data feed” which would remove the donkey work, but they are expensive.

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